The Future of the Euro: Why Europe's Key Currency is Doomed

[Editor's Note: Silver and gold skyrocketed for months, while the U.S. dollar plunged. Most investors expected those trends to continue. But Money Morning's Jack Barnes, a former hedge-fund manager, knew better. He warned ofa looming reversal that would stand the global financial markets on end. In this new Money Morning series, "The Inflection Point," Barnes examines this unfolding reversal, and will show you how to profit.]

The number of sovereign states in the EU that are facing difficulty selling new debt, or even a rollover of current debt, is growing.

The Eurozone and the EU are both in trouble. Clearly, the structure that exists today is flawed and will not withstand the rigors and pressures that are headed directly its way.

The ability to kick the can down the road is about to end, and with it some hard decisions will need to be made by the political and wealthy elite.

Let's take a closer look.

Warning Signs About the Future of the Euro

Just a moment ago, I mentioned that "the market" is ready to expose the flaws in the euro mechanism. The truth is that this is already happening. The risk-adjusted interest rates demanded by the market is now significantly higher than what the market would charge a major AAA-rated corporation for money that it borrowed via a bond issue.

As recently as a few months ago, we reached a point where the credit-default-swap (CDS) pricing on Western European states is higher than Eastern European states.

In case you are wondering, this is a first.

Simply put, bond-risk managers want to be paid a higher rate of return to insure Western Europe than Eastern Europe. This is a significant and statistically important point. The Eastern European states are only partially absorbed into the European Union. Of all the participating members, it's this group of Eastern states that could leave the EU the easiest and quickest of the participating members.

This could all help determine the future of the euro. Indeed, if you look at the big picture, the individual European states will need to consider a return to independent sovereign rule in the extreme – or at the very least a return to separate national currencies, thereby ending the Eurozone and euro currency experiments.

The number of governments that have experienced a change since this economic crisis started is growing.

That list includes all of the island nations of Europe – Iceland, Great Britain and even Ireland. (Just yesterday (Tuesday), in fact, Ireland underscored the challenges it faces and stunned observers by disclosing a plan that will have it raiding private pension accounts in order to finance the spending on its job-growth strategy.)

Even in the heart of continental Europe, the number of nations experiencing wrenching change is steadily growing. Belgium has not had a government in almost a year. And Portugal's austerity challenges are so large in scope that not even Socrates could save it – Prime Minister Jose Socrates, that is. He resigned and is being replaced.

In France, President Nicolas Sarkozy, the most visible leader of the French government, is experiencing career-low approval ratings. His party has committed a series of political gaffes, leaving it weakened and distracted in domestic politics. The current Sarkozy government is focused on G20 political events, trying to generate a positive spin on something. President Sarkozy is not expected to survive the next political round of national elections.

The European (Dis)Union – The Dissolution of the EU

In Germany, the heart of industrialized Europe, we're seeing a series of changes in the makeup of the state-level governments. The current national government of German Chancellor Angela Merkel is expected to fall, with a new coalition of parties forming a government to replace her central conservative government.

In the months and years to come, you can expect to see Germany start to focus more on what is best for Germany – to the exclusion of what is best for Europe – even though that self-interest will come at the expense of the rest of Europe.

Germany is going to be far less likely to agree to additional bailouts for other European countries. In fact, the era of unlimited access to Germany's hefty balance sheet is just about over.

The implications for the EU's overleveraged "PIIG" nations (Portugal, Ireland, Italy and Greece) – which no doubt believed they would always have access to Germany's deep pockets – have yet to be fully determined. But to modify an old Wall Street adage – "Bulls make money, bears make money, PIIGS get slaughtered" – when Europe must do without Germany's deep pockets, investors can expect casualties.

So while the idea of unity in Europe may have merit, and the future of a unified Europe is still open to discussion, the cold reality is that the EU, as it currently exists, is on life support. And in its current state, the union and the currency won't even make it to the end of 2012 – at least not in my opinion.

One major problem I see is that the European Central Bank (ECB), which handles the monetary policy for the 17 Eurozone member states, is not properly capitalized to handle the demands being made upon it.

The ECB is tasked with providing independent monetary actions in an environment of extremely intense political and economic negotiations between historically sovereign states. Needless to say, the most sensitive topic is how much each of the more-affluent member states will provide in the way of financial support to weaker sister states (a key reason that Germany is going to become so much more protective of its national balance sheet).

The Irish Connection and the Future of the Euro

Since its beginnings last summer, the European debt crisis has been a major cause for concern, with global investors worrying that it might cause a double-dip downturn in world economies and financial markets.

But as I told some of Money Morning's top editors and writers during one of our regularly scheduled "private briefings" several weeks ago, the drawn-out nature of this affair has helped diminish its impact. At that same time, however, I told the editors about a particular set of circumstances that could serve as the catalyst needed to transform the European debt crisis into a full-fledged conflagration – an inferno intense enough to bring about the dissolution of the euro-currency structure.

The catalyst I identified was Ireland.

And Ireland will play a key role in determining the future of the euro.

In the midst of the growing sovereign debt crisis last year, Ireland was forced to seek a bailout because of an economy that shrank 15% from where it was in 2007. Needless to say, debt, too, was a problem: Government borrowings – about 25% of gross domestic product (GDP) at the end of 2007 – are projected to peak at 116% of GDP in 2014.

"I think we can deal with it," new Irish Prime Minister Enda Kenny said during a meeting of the Council on Foreign Relations in New York last week. "The scale of the challenge is enormous but so is the opportunity."

The new government was brought into power to renegotiate the deal that the last government agreed to with the ECB and International Monetary Fund (IMF). This agreement is both technically in effect and technically not fully agreed upon. In other words, it's in kind of a "limbo" status, leaving the Irish government room to demand renegotiations. Prime Minister Kenny is seeking a reduction on the average 5.8% interest rate his country is paying on that aid.

In much the same way that Iceland had banks that were larger than its entire domestic economy, the Irish banks had grown their own balance sheets beyond the size of the nation they represented. As a result of this levering up process, the tab for bailing out the banking sector could swell to $101 billion – or $21,610 for each of Ireland's 4.5 million citizens.

In other words, in a country with a nominal gross domestic product (GDP) of about $230 billion, this banking mess has left "the people" on the hook for debts well beyond anything that they could hope to pay back.

In briefing Money Morning's editors, I said that if Ireland's leaders proved themselves willing and able to indebt the country's future generations – to force those generations to cover bad loans made by what had been the country's "private-sector" banking business -I could see the European debt crisis intensifying in a way most observers just weren't seeing.

Those banks are now being nationalized, and the risks absorbed by the balance of the people.

Making matters worse is the reality that renegotiating the bailout package may be easier said than done.

Germany's Merkel is now in a position where she can't afford to appear to be bailing out any of the EU's PIIG-member states. At the same time, it seems that Kenny's new Irish government has staked its future on providing a reduction in the costs of the bailout.

The bottom line: Neither the Germans nor the Irish appear to have an acceptable compromise to present to the home crowds.

On top of all this, looming quickly is the big sovereign-debt rollover for Italy and Spain, which combined owe about $400 billion. It is a sum that "the market" is not likely going to want to provide on terms either government will find acceptable.

This leaves the already-broke ECB, and its new "bad-bank" twin, the European Stabilizing Fund (ESF), along with the IMF, to ride to the rescue. The rescue will not be piecemeal, but will, in fact, be a major package for most of the liquidity-starved states.

The cost will most likely come in the form of giving up individual sovereign rights, while protecting the banking system from itself.

And if this all can't be ironed out, then the future of the euro will be very, very clear. And so will the currency's epitaph.

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I completely disagree with you. Painful though the process will be, the current difficulties are forcing monetary integration (as opposed to political integration) within the EU to accelerate. European governments have no choice – they will do what needs to be done to fix this problem, which is an EU-wide issue rather than one isolated in Greece, Portugal, Ireland, etc. One might even argue that such monetary integration would be impossible without such burning pressures as are currently being encountered. There is no mechanism for an EU member country to withdraw from the Euro; only from the EU itself. Were a country to signal that to be its intent, (in order to reintroduce its own currency in order to devalue its currency) then the capital flight from that country would be immediate and probably fatal to its entire banking system. Not an option.

Well documented article, but still flawed.
I am neither Dollar nor Eurozone resident and thus may pretend some indepence.
That the Euro is in bad shape is nothing new, but weren't it for the Fed's possibility of continuing printing Dollars like hell, the US would be broke for years already.
Last year American hedge funds tried to talk the Euro down to parity and they all got squeezed out, not least by the Chinese who have got more Dollars to sell than America could ever buy, not to speak of all the other holders of the US currecy.
Admittedly, its a race to the bottom in fiat currencies, but over the longer run I still believe the US will be the fastest to debase its currency.
And don't tell me the Fed is less broke than the ECB, its all the same bad bag. Even the Swiss National Bank – who is still able to print currency – sits on far too big an amount of US dollars, proportionally more than the Chinese, if calculated per capita of population.
The outlook is not rosy, a intermediate rise of the Dollar is quite possible and even desirable, because its purchasing power parity is not respected. However – until further notice – its the US government's desire to debase the Dollar to settle its debt situation. Hence, and inflection point may be (or not be) there, remains how long it will last.
I have the uneasy sentiment that this investment advice is just as much an attempt to buy time before the ultimate demise of the US empire of debt.
I am not running a position in USD, neither short nor long, at the moment. However my 40 years experience in the Forex market have shown me the general trend of the Dollar, and unless US politicians get their fiscal house in order and the US as a country stops living beyond it's means (see todays trade deficit) ther will hardly be a long term sustainable Dollar rally.
I have seen USD / CHF at 4.2960 in 1971, its 0.8810 at the time of writing. There have been severe ups and downs on the way along to the present day, but whenever the Dollar got too strong, the US were asking for intervention to bring it down.
Best regards

Well…..it seems to me this is an exaggeration, is origin being probably due to the perpective of an American who views the dollar and the Euro as the two dominant world currencies. In a continuous 'prestige' struggle the dollar should "beat" the Euro! I am afraid there are many surprise ahead of us, regarding both dominant currencies and their survival.

Rob assumes the EU will do what it takes to "fix this problem?" Most governments are managed by self protecting bureaucracies full of people who don't understand money and as such don't fully understand how they got themselves into the problem in the first place. As such their solutions are based on the same flawed perceptions and result is "fixes" that make the problem worse.

Since socialism is deeply engrained in Europe, the austerity measures necessary to "fix the problem" and the necessary public mindset of personal responsibility for one's needs will be as foreign as democracy is to the nations of the middle east.

'Democracy" is how they ended up with the problem and the adherence to democracy is why they will not succeed with a solution. The shift from self governance via a representative republic to a democracy is how the U.S. got into it's problems and is the reason we will not fix our problems before a grave consequence forces us to move away from democracy. This is setting the western world up for forms of government that will fill the void that a few years ago would have been unthinkable.

I am not sure I can agree. The argument made is the standard first impression everyone seems to be drawing. I do agree that Germany will do what is best for Germany (which is what they should be doing). But what is best for Germany is to have access to cheap labour and cheaper infrastructure, AND it is currently evolving and developing that infrastructure across Europe. With a single currency each of the Euro members are going through an evaluation process, a painful process without a doubt, but it provides positioning. In the longer term Europe will evolve taking advantage of efficiency resulting from this positioning. This process is not that different from the American experience. The American states are not equal – manufacturing goes where it makes economic sense. This calculation is accommodated with a single currency.

Extract from he future of the europe" cost will most likely come in the form of giving up individual sovereign rights, while protecting the banking system from itself.
Why can't the US applying the last part of this sentence to its banking system. Americans, but bankers, are still suffering from this irresponsible lack of discipline and regulations.

Here we go again with the scenario Europe's demise, America's recovery type BS. Don't make me laugh! When I see write ups like this, to me it's just a ploy to try to get people to think the US is not in as bad (but is in fact in worse) shape as the EU.

Never underestimate the capacity of Euroland to fudge and smudge and reach any kind of deal they like. The peoples' voice and opinion does not count for much. The ruling elite swill do what they want. The Euro is a political animal, and I can't see- this elite giving it up. It would rathr make the rest of the world suffer first. Thiat is why the markets keep buying the Euro, over-valued as it is. The speculators are placing bets on the politicians, not the markets.

I agree with you 100% . Who is NEXT, well its SPAIN. The unemployment rate in Spain is 21%, and their economy is a basket case. There is no way they can service their debt AND EUROPE HAS AN ECB PRESIDENT THAT MUST BE THE BIGGEST MORON, to increase interest rates and then talk some more about further increases,has made the Euro unduly strong,and caused all their economies to slow even more. WHAT IS THE LEAST OF THE BIGGEST EVILS???? GET ON THE
DOLLAR BANDWAGON.

i just dont see a more flawed currency than the dollar and its great you saw a trading opportunity in the dollar as sentiment was way too bearish but i really think your tipping points should be reversed.Fiat money never lasts functioning healthy more then 30 to 40 years .us dollar unbached fiat since 1971.euro still has a ways to go before destruction…imho

A little while ago we were reading about the imminent collapse of the US Dollar and total economy. Your writers were telling us that pretty soon there will be no countries that will accept the US Dollar. That the US Government will raid the pension funds, control the banks and in general the US will become worse than a bananna republic.

Now it is Europe and the Euro that is going down the tubes.

I notice that all of these writers just happen to be selling something along with their predictions.

But heres the the real bombshell. Should these predictions take place I would predict the next phase of this progression to be Anarchy. Then where will Wall St. and money markets end up? Just how much of this crap do they think people will put up with.

What is really needed here is for somebody to take charge of Wall St. and put an end to all of this scare mongering speculation on commodities and money. Get on with fixing all of the damage that has been caused by the greed on Wall St. and remember it was those same people who caused this total world screwup to begin with. Off to prison with all of them so they can learn the reality of economics and market manipulation. Either that or send them out into the real world and see how they survive.

The odd thing about all this Euro talk is what appears to me to be the complete lack of understanding about the roles, controls and effects of currencies. Long term, major countries cannot share a currency unless their politicians and voters think the same way economically AND politically; this reality has been obscured in the Eurozone by massive deficit spending, but now the chickens are coming home to roost. Just one example of the many politico-economic differences … since democratising, the Mediterranean countries have needed price inflation to compensate for the excessive demands of their volatile workforces and voters, whereas the Germans have (postwar) pursued policies to minimise the risk of inflation.

Even if the European nations were to become a single 'Euroland' (which is one of the aims of the Bilderberg Group), it would be an economic and political disaster because, unlike the case in the USA, few Europeans are willing to migrate across regions to where the work is. As a result, whole regions of Europe would be in permanent recession while other regions would be growing economically – a recipe for unrest and instability.

Any country CAN leave the Euro – it is nonsense to say 'there is no mechanism'. If pushed too far, the Germans WILL go back to the Deutschmark – the only economic problem would be the large capital inflow and a sharp rise in the currency. Obviously, for the PIIGS countries, the consequences of leaving the Eurozone would be drastic; however, if their populations take away the other options available to their politicians then, without Germany's support, they will have to exit.

Finally, I would very much like to see the assumptions made in any Eurozone simulation model that indicates long term stability and growth. I have just spent half an hour googling Eurozone economic models, but have not come across anything useful. Has anyone any information on such models, and their political and economic assumptions?

I have several questions.
(1)If the Euro was to fall hard, what would the likely effect be on: the U.S. dollar and the U.S. stock market? Would we see a flight of capital into the U.S. from Europe? Are we already experiencing this?
(2) What would be the effect on the U.S. stock market, if Greece or another PIIG nation defaulted on its debt?

That's kind of a broad brush you paint the EU with, ignoring the significant differences between the countries that are in “crisis” in your opinion. How is the Belgian government or Sarkozy’s popularity relevant anyway?

The key is the money generating capacity of these economies. Ireland, your main culprit, had a flourishing economy and a very modest debt of 25% of the GDP before the GFC. The government decided – perhaps somewhat foolishly – to secure the bad debt of the Irish banks. What your article forgets to mention is that most of this bad debt is owed to big German banks; so the German bailout is far from altruistic; they are bailing out their own pensioners and other German depositors. Spain also has a fairly robust economy, though the property boom has resulted in capital misallocation and lots of empty houses (sounds familiar?). These economies will trade out of their problems, given time.

Greece – and perhaps even Portugal – is a completely different story: they have been living above their means for many years and gradually built up their debt. They will have to make painful re-adjustments, which is already in progress. Again, much of the debt is owed to German banks so Germany cannot allow them to go under but wants to maintain the pressure, that’s why the bailout money is not flowing freely. What might alleviate the pain is that Southern European countries have a large informal grey economy and strong family ties that will help them to pull through. Luckily Greece and Portugal are a very small part of the EU economy.

If I might quibble with Mr. Barnes' editor's note, the problems with the Eurozone and the Euro currency will most likely benefit both the dollar (short term) AND the metals (longer term…and short term as well if the crisis flares in earnest.)

They have caused a rush to both before. All currencies are suspect now, to put it mildly. Periodic smackdowns notwithstanding, gold and silver will attract the refugees.

Another catalyst may be Greece which must now be bailed out a second time. Der Speigel says that its exit is definitely being contemplated. But Greece is highly indebted to the German and French banks which will take an enormous hit on even a default let alone a bailout. As with Ireland the question remains to what extent the population in the eurozone is willing to bailout the bankers.

Unbelievably naive. The EU was started to simplify trade. This it achieved efficiently. That continued for the last 40 years of the last century and up to the present. The common currency was introduced to simplify the terms of trade even further. Is there anyone out there who believes this has not been achieved? Besides you, Mr forex trader who lost his job. Let me put it another way: does the sub economic performance of the state of Alabama jeopardise the value of the US dollar? Hell no, poorer and richer states all combine to give one perception of the currency. Possibly China would like Alabama out of the dollar; Southern man won't go.
The Euro will fluctuate which will benefit exporters on weakness and importers on strength. The PIIG countries will have to borrow at high rates and adjust their prices (in Euro) to compete and survive.

Sure the Euro is weakening this was expected and so is the US Dollar lots of intertwined reasons here, but the Euro has a stability problem it is flawed. Whilst many try determinedly to prop it up its real value is very much lower. It is being slave to some, master to many, but friend to all so business experiences are allways bad, why is it no-one at the helm can see or have sense

Scare your reader with some hot new story, and then offer the same reader an easy way out, offering him a less risky investment, that normally he wouldn t r isk. Combine that with the traditiohnal allergy of americans for anything european, and you ve got articles like this. I m quite sure that since the arrival of the Mayflower, most americans think nothing good has come out of europe ever again. Of course this article is square nonsense. the writer is forgiven though. it s true that the every major guy in the financial world is trying to break the back of greece, with the ulterior motive to disrupt the european economy. money is to be made on the misery of others, that s an old paradigm in the financial market. and of course it s more easy to go for greece than for california. but on the other hand it s easier to bail out greece, than california.

Your analysis is flawed there are 27 countries whose currency is the Euro as to the United Kingdom it is not part of the Euro and its currency is the pound.
Right now I have more confidence in the British pound than the Euro or the dollar. I do not see the Euro collapsing; it may lose value as all other currency.
Politicians have been spending like drunken sailors in Europe and the US for decades.
The US dollar is in more serious problem than the Euro based on the fundamentals; in ten short years the US has piled up more debt than in the previous 224 years since the signing of the declaration of independence.
That's an increase of over $500 billion each year since 2003, with increases of $1 TRILLION in FY2008 and $1.9 TRILLION in FY2009, much of it borrowed from foreign central banks.
At the current pace, it is slipping by $3.9 billion deeper into the whole every day — $163 million per hour. That means that by the time you finish reading this web page, we'll have saddled our kids and grandkids with another million or two that must be repaid.
Long range planners in Washington are forecasting these crazy deficits could continue for at least another ten years, ballooning the official debt past $20 TRILLION

i am Italian (one of the Piigs) … and i think :
* i agre with you in the medium/long term (may be 2012)
* but you forget that the Public Debt of Usa ($) ed Japan (Yen) it's UNSOSTAINABLE in the medium/long term like Euro !!!
* so.. the Cross Rate Euro/$.. may be that for the next months collapse
* but on the long term also Usa collapse
*ALL the Western Continents are in a looming macro-cicle

*** and for this reason… i think that Gold in the short term could go up and down.. but even if the Interest Rates will go up in the future.. this will be caused by a Wester (Usa+Euro) Deafaul Risk… so in the Long Term the Gold will be the ONLY Safe place..

This reasoning sounds like impossible to accept for European believers while, we have never been closer to a complete failure of the euro. Euro is nothing else but the german Deutsche Mark and germany isn't willing to finance the whole eurozone. Even though Germany prime minister would agree, people would fully disagree.

Whether we like it or not, the Euro is weak because the fundamentals of the various economies of the Eurozone are very bad and the differences between northern and southern eurozone countries are huge.

If Germany can deal with a EUR/USD at 1.70 or even 1.80, none of the southern countries, including France can survive to it. And Germany isn't willing to leave with a lousy currency. It never happened since the last world war.

where Patrick Arthus, a french economist, explains that the future of euro only goes through a massive help from the northern european countries to the PIIGS. There is no way Germany can and will agree with such a plan and there is no means in France to finance it either.

Mr Arthus concludes saying that the worst case scenario cannot happen because… it's the worst case scenario. With such diagnostic, I am afraid that the patient will not survive its doctors.

I am investing in the etf "EUO". This shorts the Euor. Im going to sit down, enjoy my coffee and watch euro theater as academics and bureaucrats and politicos of the old continent do what they must to save their own.

Portugal, Italy, France, Germany have gold and metals and resources to exploit. The UK dumped its gold at $254 US, an ounce and Gordon Brown and Labour did OK in the last election although that 60 minute move cost the UK at least $30,000,000,000 ( so far).

Greece has temples, tomatoes and pita bread.

Germany is going to explode in anger.

Let the reprofiling begin. The big losers will be the Palestinians and Hamas if the Euro falls a lot.

Everyone is walking and kicking the hot potato !!!
No politician will even mention it !!
The Population is to large , in the next 30 years the world population has to decrease 80%.
For last 100 years the world economy begame more and more depending on CHEAP ENENERGY!
And those TIMES are over !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!
+/- 50% of everybody leaving education will never get a JOB .!
And this can only get worse with increasing population !

Congratulations! We are in 2014 now and neither the EU or the Euro have disappeared yet. Maybe you should write your own epitaph as forecaster. It was because "economy analysts" like you that all the boom was created and exploded. Don't pretend now to be smart. You know nothing, less than the average man.

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